IntriCon Corporation
Q2 2019 Earnings Call Transcript

Published: 11 Aug 2019

[Operator:]

Good day, ladies and gentleman, and welcome to the IntriCon Corp. Second Quarter 2019 Earnings Conference Call. [Operator Instructions]I would now like to introduce your host for today's conference, Leigh Salvo. Ma'am, you may begin.

[Leigh Salvo:]

Thank you. Before we begin, I'd like to preface our remarks with the customary safe harbor statement. Today's conference call contains certain forward-looking statements. These statements are based on the current estimates and assumptions of IntriCon's management and are subject to uncertainty and changes in circumstances. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Actual results may vary materially from the expectations contained in today's call. Important factors that could cause such differences include, among others, those set forth under the headings Risk Factors and Management's Discussion and Analysis of Financial Condition and Results of Operation in our 10-K filing for the year ended December 31, 2018.With that, I would now like to introduce IntriCon's CEO, Mark Gorder for a review of the company's second quarter performance. Scott Longval, the company's COO and CFO will then cover the financial results in more detail, and we will open the call for your questions.

[Mark Gorder:]

Thank you, Leigh. And thank you everyone for joining our call today.As we enter the second half of 2019 our team continues to execute against the priorities we established at the outset of the year, while carefully planning for several exciting growth opportunities on the horizon.To quickly recap our priorities for 2019 include; one, meet the demands of Medtronic; two, pursue development opportunities in our Medical Biotelemetry business that leverage our core competencies and diversify our revenue base; three, seek partnerships with best-in-class entrants in the emerging OTC hearing aid market; and four, prudently expand our direct sales initiatives with Hearing Help Express while tempering our marketing and advertising programs.Our second quarter performance highlighted our commitment to executing on each of these priorities as we continue to focus on our two core businesses Medical Biotelemetry and Hearing Health. In both of these segments our strength as a micro-miniature device producer allows us to enhance the mobility and effectiveness of body-worn devices.Today, we are accomplishing this through partnerships with highly respected market-leading companies throughout the world to provide high-quality medical devices, while selectively pursuing opportunities to reach end consumers directly.During the first half of this year, we took a number of significant steps to better position the company for long-term growth and to thus our focus our priorities on our near-term core competencies. As most of you know several weeks ago we pronounce revenue of $29.3 million, which excluded contributions from our discontinued operations in the U.K.I'd like to take the next few minutes to highlight some recent updates. Our priorities for the remainder of this year and how we are positioned the company for longer-term goal. Following my remarks, Scott will offer a more detailed review of our financial performance and updated guidance for 2019. We’ll then open the call for your questions.Starting with our Medical Biotelemetry business, revenues for the quarter increased approximately 3.4% year-over-year and represented 71% of total revenue. Revenue growth in this segment of our business continues to be constrained by order volume related to Medtronic’s ongoing global, commercial product launch.During the annual meeting of the American Diabetes Association in June, Medtronic's presentation highlighted their continued confidence in the near-term momentum and sustainable growth potential for its 670Gwell into 2020, specifically in international markets where they are only just beginning to ramp up in selected parts of Europe, Australia and other markets around the world.Encouragingly, Medtronic's highlighted growing continuous glucose monitoring adoption and it’s increased penetration in the international markets is a catalyst for their growth and more recently, they announced their pre-market approval submission to FDA requesting approval for non-adjunctive labeling of their Guardian Sensor 3, which if granted could broaden patient access. As an important long-term partner to IntriCon, we view this commentary as a further validation of our long-term growth opportunity in this segment of our business.As we announced a few weeks ago, we secured a four year contract that further validates the strength of our relationship and commitment we shared delivering superior products in diabetes management. We're excited to be partnered with the market leader in this rapidly growing space and look forward to continuing to support them in the future.Importantly, we remain committed to diversifying our medical business. We continue to pursue opportunities in other market segments that can benefit from our design, development and manufacturing capabilities. In an addition to the important inroads we're making with potential customers for various medical coil uses, we are also pursuing other biotelemetry monitoring applications that hold significant longer-term potential.On the manufacturing front, we are progressing with the required validations and qualifications of our new facilities and equipment. As a Class 3 manufacturer of medical devices and components, the process is filled with rigorous requirements and I'm pleased with the ongoing progress. While the final validation and qualification requires customer action, upon completion, we will be operating at approximately 60% capacity, positioning us to meet anticipated demand growth in the next several years.Turning to our second core business segment, Hearing Health. We delivered valued solutions to customers, directly or with partners, through a comprehensive ecosystem of outcome based hearing health care tools, including high-quality low-cost products, technology, service and support.In this segment, total revenue in the second quarter was down 13.6% over the prior year second quarter. Our go-to-market strategy in hearing health includes three channels; indirect to consumer, direct to end consumer and legacy OEM. I'd like to take a few minutes to cover some recent updates in each of these channels.Starting with indirect to end consumer, which comes from customers who sell to the end user to non-traditional models. We posted revenue of $2.4 million in the second quarter of 2019 down over the prior year period. Order delays associated with restructuring activity within a large insurance company’s hearing health business impacted our sales in the quarter and are expected to continue through the remainder of 2019.One of our strategic priorities to pursue partnerships that will enable us to be a dominant early participant in this emerging value-based hearing health market. Looking ahead, we're continuing to seek opportunities with other independent hearing health participants and market entrants that can combine our hearing aids, softening software and customer care with a highly effective consumer marketing and brand recognition. We are excited to have identified a meaningful number of potential candidates and are commencing discussions with several of them.Turning to our direct-to-consumer business. Hearing Help Express revenue in the second quarter of 2019 was $1.7 million. As we have highlighted in the past, we are very excited about the emerging opportunity to directly reach hearing aid consumers. While we monitor legislative progress, we plan to continue to selectively pursue direct sales initiatives in a measured approach while incorporating the insights we have gained in building an ecosystem of care to address this emerging channel.As a result, we intend to reduce cost to a prudent and sustainable level based on data-driven analysis while we optimize our model. And finally legacy OEM revenue, which represents products sold into the traditional hearing health market, continued to decline as anticipated.For the second quarter of 2019 legacy OEM revenue was 2.5 million, a decrease of 16.6% over the prior year period. Earlier this month we completed the sale of our U.K. Limited subsidiary accessory business assets and entered into a new U.K. distribution agreement with Puretone Ltd. And in connection with this repositioning, we closed our U.K. facility, resulting in an annual cost reduction of approximately $1 million.On the regulatory front, we were very pleased to see an update from the FDA in June, that highlighted action on the anticipated OTC regulation. We believe this update signals the regulation is moving ahead as expected and we look forward to potentially seeing draft guidance as early as this November.This legislation is designed to drastically reduce the cost and increase the access to high-quality hearing health care in the U.S. market. We're taking steps to ensure that IntriCon’s core competencies are best leverage to provide innovative hearing health solutions, such as self-fitting software and remote care, the most efficiently meet the needs of the vastly underserved U.S. hearing-impaired population and help remove the significant barriers that exist today.In summary, looking at our hearing health business holistically, I’m confident the changes we have made not only reduce costs but will better enable us to focus resources on the emerging opportunity we have to disrupt the estimated $3 billion addressable hearing health market in the U.S, particularly in light of the pending legislation I just highlighted.I'm confident that our track record for excellence combined with our unique ability to deliver state-of-the-art technologies, including wireless digital hearing aids and sophisticated self-fitting software solutions coupled with our customer care competency resident in our DTC operations thus positions us to be a significant participant in this exciting and expanding market.Now I would like to turn the call over to Scott to discuss our financials and guidance in more detail.

[Scott Longval:]

Thank you, Mark.Turning to our financial results. For the 2019 second quarter, we reported net revenue of $29.3 million relatively flat from the prior year. Growth continues to be fueled by our Medical Biotelemetry business are offset by what we believe are temporary declines in our hearing health business.Second quarter gross margins were 28%, down from 33% in the second year -- in the prior year second quarter. Gross margins were constrained by ongoing validation and qualification expense in excess capacity related to the recent manufacturing expansion to meet the anticipated higher volume requirements of existing and future customers.Operating expenses for the second quarter were $11.6 million compared to $6.7 million in the prior year period. The increase was driven by a $3.8 million non-cash wire- off of Hearing Help Express goodwill and intangible assets, higher non-cash stock compensation expense, increased advertising investments in our direct-to-end consumer business and support cost related to key new business development initiatives.As Mark noted above, we are committed to lowering costs and gaining efficiencies in our value-based direct-to-consumer hearing health business, as we refine our sales model to better align with the emerging market opportunities.We posted a loss attributable to shareholders of $5 million or $0.57 per diluted share versus net income attributable to shareholders of $2 million or $0.25 per diluted share for the 2018 second quarter. Excluding the one-time non-cash write-off, we posted adjusted net income from continuing operations of $256,000 or $0.04 per diluted share in the second quarter of 2019.Turning to guidance. As previously announced, full year 2019 revenue is expected to range from $115 million to $117.5 million. Full year 2019 gross margin is expected to range between 27% and 28.5%. The reduced guidance primarily reflects the following anticipated factors

[Operator:]

[Operator Instructions] Our first question comes from Andrew D'Silva from B. Riley FBR. Your line is now open. If your phone is on mute please unmute it. Mr. D'Silva, your line is now open.Our next question is going to come from Jon Block from Stifel.

[Thomas Stephan:]

This is Tom on for Jon. Thanks for taking my questions. Scott, maybe I'll start with you. On the medical side, our partners had some recalls, can you maybe explain a frame what that means for IntriCon?

[Scott Longval:]

Yes, obviously I can’t into specifics in terms of our customers and recalls but what I can say is the businesses that we’re in and the relationships that we have and the products that we do with our customers aren’t associated to any recalls and so going forward we don’t see any sort of meaningful impact to us related to some of the -- the point you referenced.

[Thomas Stephan:]

Okay, that's fair. And I guess sticking with medical. Doug's now been with the -- Doug Pletcher's now been with the company for I think around six months. You already have had some small wins with medical, but can you talk to your conviction on more material medical wins over the next 12 to 18 months relative to where it stood six months ago?

[Mark Gorder:]

Certainly, I'll take that. Doug, we've given him the task to go out and define the strategy for getting into our new medical business and so he is well on the path doing that and identifying several very interesting market opportunities and over the coming quarters we will try to delineate those opportunities more clearly to our shareholders. There are a little bit more vague at this time but we are definitely generating some very good opportunities in areas like a brain monitoring in epilepsy, sleep disorders.And then as you mentioned in the medical coils area, there are a number of new applications growing in that area for using interventional catheters. The existing business that we have at international -- in coils is in two areas; one is programming of pacemakers and the other is interventional catheters and some of the interesting areas there are doing cardiac ablation treatments and measuring positioning of those probes and taking biopsies in the lungs and trying to more accurately position taking those biopsies and Doug is making significant inroads in defining market opportunities in all of those areas.So we’re going to anticipate that over the coming quarters we will be much more definitive in where we’re going there but in the short term you should continue to see a good progress in our medical coil area. Just a number of opportunities we’re working on for some time that are starting to bear fruit and I think the numbers are kind of starting show them.

[Scott Longval:]

Maybe -- this is Scott, maybe I’ll just follow on to Mark's comments. One of the things that we’re very excited about is been the response to our already developed core technologies and core competencies and how they fit into some of the opportunities that Mark laid out.As we’ve talked about when we first brought Doug on, we're very internally focused working with our existing OEM customers, Doug has been much more externally focused and through that we obviously believe that our technology and our competencies would be well received in the medical community and that’s what we’re finding out. So now to wane some of the shorter shorter-term opportunities with a longer-term larger opportunities and how we proceed those. And to Mark’s point we’ll look to update the group, as we proceed over the next six months and on into 2020.

[Mark Gorder:]

And I guess, and I would close with this one additional comment is that. It's -- we went into this feeling that our core technologies would be very well received by many other medical device customers if we made the investments to get out there and identify those areas and we’re not disappointed in what we’re finding.

[Thomas Stephan:]

Awesome, that's really helpful color. And then one quick one on hearing, if I may, can you just remind us where you are with the self-fitting hearing initiatives? Thanks, guys.

[Mark Gorder:]

Yes, definitely. The -- as we announced in prior releases, we have been working with a company in Germany Soundperience, on developing a self-fitting technology, we call it Sentibo, that’s been in progress in Germany for some time. We’re intending to bring that over to the U.S. market and adapt it to use in our direct-to-consumer channels, both with ourselves and with partners and we're currently in the process of working with the FDA on submitting 510K for clinical trials to prove out the technology in the U.S. market that's required before it can be used.And we’re well along the path of having discussions with the FDA and defining exactly how that clinical should go forward. So we think we are on track with carrying that technology available in a timely manner when the OTC regulations are actually put forth and enacted, which we expect to be sometime around mid-2020.

[Operator:]

Thank you. And our next question comes from Andrew D'Silva from B. Riley FBR.

[Andrew D'Silva:]

Thanks for taking my questions, and sorry if you highlighted any of this, I was moving between calls. So just let me know if you did and I’ll check out the transcript tonight but could you just quickly just touch on what stock-based comp, depreciation, amortization on, cash flow from operations and CapEx was Scott? And then Mark, as far as the 670G goes, I know you referenced international launch and that being some of the reason for the revised guidance.But Medtronic provided a fairly consistent update as far as their annual outlook goes, could you maybe clarify the difference between the two outlook, as far as your revised guidance and then maintaining theirs?

[Scott Longval:]

Excellent. Andy, this is Scott. I think I’ll take both of those questions. For the stock-based comp for the quarter 537,000, depreciation and amortization was 818,000, cash flow from operations was 1.7 million and CapEx for the quarter was 1.4 million.

[Andrew D'Silva:]

Thank you very much.

[Scott Longval:]

And then in terms of your question on Medtronic and the outlook that they provided at the ADA in early June, they give a presentation where they talked about organic growth of 6% to8% for their fiscal year 2020.Keep in mind their fiscal year runs essentially May 1 through April 30.And so they talk about their 2020 fiscal year, that actually leads into our fiscal 2020.And then further if you look at the guidance they gave, they talked about most of that was going to be on stronger second half launches, particularly in the international market. So if you think the stronger second half for them, really is our November through April. So that gives us again a lot of confidence as to where that business is moving.We wanted to take in more cautious approach as we thought about guidance for the second half of the year, because this has been a little bit illusive in terms of the timing and so that was the -- the task that we took and we thought about guidance but also then the confidence that we had is we move into 2020.

[Andrew D'Silva:]

Okay, so it would be a fair assessment to you say that there is a chance, so some of that could fall into the fourth quarter or that that 2020 for your calendar year would be very potentially strong in the beginning of the year relative to this year?

[Scott Longval:]

That's definitely true consistent with the remarks.

[Andrew D'Silva:]

Thank you very much. And there -- Medtronic again is expecting to have a pretty big overhaul next couple years when it launches its PCL platform, could you maybe let us know how you are integrated today and how you’d be integrated in that platform, it’s just a very different looking CGM system, I am just curious how the disposables would work?

[Scott Longval:]

And so another great question. As part of that ADA presentation, they outlined their product pipeline. For the next several years, the 670 obviously, which they are still battling it in international approval, the next generation pump, the 780, which again they're targeting to get approval here in the U.S. in the next 12 months and then eventually it will find its way into the international market and our both of those platforms are built up off of the CGM that we provide for Medtronic today.And so as you think about the next several years coming off of those lines, we feel that we’re very -- positioned very well in place for growth. As you think about the personal closed-loop platform that you talked about. They highlighted that it initially it looks like it’s going to be based off of the current transmitter platform that’s out but eventually that visions into a disposable CGM that would be ultimately something that that could support the personal closed-loop system.We can’t get too far ahead of ourselves in terms of what we talk about our customers business due to confidentiality. So I can’t go into great detail. What I can say is obviously, we worked with Medtronic for quite some time. We just signed a four year supply agreements that I think kind of signifies their confidence in what we do and what we can deliver and so as they start to envision new platforms, we want to make sure that we’re at the table talking to them and making sure they understand what we can provide. So all I can tell you is that we’re aggressively doing that and we feel confident with that relationship.

[Andrew D'Silva:]

And last question for me is just related to the OTC Hearing Aid Act and the guidance that I expected to come out from the FDA. Could you maybe elaborate on some of the pushes and pulls and what could be viewed as an like a very positive guidance and what may be would be in your eyes a not so great outcome?

[Mark Gorder:]

Yes, I’ll be glad. I was just out visiting the FDA couple of weeks ago, on July 23 to discuss our 10K submission and we had a pretty good discussion about that and I think the legislation highlights a couple of things that are critical to us. One is that the regulation should allow for perceived mild to moderate hearing loss and the work perceived is important because a lot of times people perceive their hearing loss to be better than it is.So for example, you might have severe hearing loss, you know asked you the question, you might say, well, I’ve got moderate hearing loss. And that’s kind of well-known. So what the legislation allows is for the consumer to decide what is mild to moderate. That's good for us because the -- that allows for a more, higher power hearing aid to be sold in to the OTC market which increases the addressable market that we can obtain with the OTC category.And our feeling is that the FDA is going to be relatively liberal on that regard. There was already some published -- they already approved an FDA De Novo application composed for a self-fitting device that have a power level of about 120 dBSPL, which is pretty good from our perspective. So the fact that that's already been approved indicates to us that the legislation is going to be pretty favorable going forward relative to specifications that would allow a relatively large addressable market.So what we know so far we’re pretty pleased on what we’re hearing and the Commissioner of the FDA issued a document a few weeks ago, I don't --I can probably have Scott dig up the reference but they indicated that there was going to be a November issuance. I was notable to confirm that during my FDA discussions, but the commissioner did put that in a public document. If that's the case, then the FDA has six months after the issuance to actually put out the regulation and that includes a public comment period. So we’re pretty optimistic that mid-2020, the regulations will be in place.

[Andrew D'Silva:]

Sorry, Did I actually had one more question. The comment period can be included in the six months or if it’s 60 days and then it would four months from there not 60 days plus six months?

[Mark Gorder:]

Correct. We understand it and this was a discussion we had, the FDA legal department has indicated that they believe that 60 days is included in the six months.

[Andrew D'Silva:]

Okay, that's new to me. Thank you very much and best of luck going forward.

[Mark Gorder:]

Thank you.

[Operator:]

Our next question comes from Dick Ryan from Dougherty. Your line is now open.

[Richard Ryan:]

Mark to tag on that FDA. Can you file your submission, your 510K or when in the FDA process can you file your 10K submission?

[Mark Gorder:]

Well, what happens is we put in a pre-sub application and we request the FDA give us guidance as to the outline for the clinical trial models that we are proposing. And we had this meeting on the 23and they are relatively -- they were very -- was a good dialogue, a good I would say collaborative dialogue and we got a good positive response out of them.So we can start our clinical trial within a few weeks and but you still have to go through the clinical trial and you have to present the findings to the FDA. They’ll review that and then we’ll give you a go or a no go. So we’re anticipating that the clinical trial will take a few months. So we’re probably looking at the end of the year before we would have us something submitted back to the FDA.

[Richard Ryan:]

Okay. So you wouldn’t have to wait if it is mid-2020, you wouldn't have to wait until then to file. You can do it in one of the processes underway, okay. What are you guys doing on the and the director to the consumer side, you're rationalizing cost but can you talk about kind of where you're taking people out of or adding your internal sales group still up and running and what's the headcount with that?

[Mark Gorder:]

I can't really speak to that but I’d say, let me speak more philosophically. What we realized is that we’ve really got to take a pencils-up approach to make sure that the advertising expenditures that we’re undertaking are producing the result we expect.So we're really trying to reduce our cost to a prudent and sustainable level while we optimize the model. So I say, we’re kind of in a product development modes and we’re trying to put in all of the measurement systems we need in order to assure that our KPIs measuring the outcomes that we expect are actually happening and so we’re going at this very prudently.So I think we talked about reducing advertising costs last quarter, we started that. We’re doing more of that as we speak and will keep you appraised as to the effect of that but you should see an improving bottom line quarter-by-quarter for the rest of the year in the extended direct-to-consumer business.

[Richard Ryan:]

Okay, and on the indirect side, that had some pretty decent numbers Q3, Q4 of last year. They’ve tailed off Q1, Q2.What are you seeing in the indirect side?

[Mark Gorder:]

So the main reason there as we said in the announcement was a restructuring going on one of our large insurance partners and we anticipate that will carry on for the rest of the year, but offsetting that, we’re continuing to look for partnerships outside of our existing ones and looking at potential partners like Bose, Best Buy, and trying to make business development efforts there, because we think some of those people could be very good indirect to end consumer partners.So even though that we’re disappointed that the restructuring took place and that’s going to short-term impact. We expect that will eventually recover and then we’re also driving -- growing these other relationships.

[Scott Longval:]

Maybe I’ll just add one comment on top of that. One of the things we're seeing as the legislation is becoming nearer and nearer is more and more parties are interested in this space and they’re coming from numerous different channels and we’re working for our partners that have the type of technology in terms of hearing aids, self-fitting software, the customer support fulfillment that IntriCon has.So as we get closer to legislation, there could be more and more people that are interested and it’s going to be our job to make sure that we position ourselves as the best case supplier for these partners and choose the ones that have business models which we think can be a successful longer term.

[Mark Gorder:]

And I’ll add to what Scott said there, so we have some very valuable assets in our direct- to-consumer business. Not only do we have for IntriCon, we have a high quality devices, we have our state-of-the-art self-fitting technology and things that are needed to build an ecosystem of care. But down at HHE, we also have very good teleaudiology capability. And pick, pack and ship capability which is critical to support some of these partners that are looking to get into the business that have marketing capabilities but they don't have that back end. So we’re looking at providing not only devices and software but also back end teleaudiology and pick, pack and ship to some very exciting partners.

[Richard Ryan:]

Okay, great. Thank you.

[Operator:]

Thank you. And I'm showing no further questions. And now I would like to turn the call back over to Mark Gorder for any further remarks.

[Mark Gorder:]

Thank you, again for joining our call today. I'm pleased with the progress the IntriCon team is making and would like to thank them as well as our shareholders for your continued support. We look forward to seeing many of you during upcoming conferences and marketing trips. Have a great evening and thank you for participating in the call.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a great day.